Impact of Rate Hike and Earnings

A shocker of a week where global equities sold off sharply in a delayed response to US Fed tightening and a consequent ramp in yields. Such a hike hangover may seem to many like a bitter and obvious pill in retrospect. But to blame the stock and risk aversion dollar fall simply on the Fed, as Donald Trump has done, does not tell the full story and therefore what is likely to happen next—through a now even more important Earnings season. Today’s newsletter looks at what is really moving this market and therefore short and medium term trading opportunities into what we still believe will be a particularly Italian dimension for Europe and our still bullish (and long) EURUSD outlook—and to be published hopefully at the right time.

As we enter the US earnings season, we could do worse than take the advice of two of the most renowned stock pickers of this century: Warren Buffet and Sir John Templeton.

There are two main drivers to the current market: bonds (the effect of rate hikes on inflation and therefore yields) and the earnings season (economic growth) that started on Friday. The impact of further Fed tightening was initially to push yields higher and stocks down and the Dollar up.

Stocks were pushed down to levels that would attract optimistic buyers in the expectation of positive growth led earnings releases. Complacency possibly but with historic justification. The average earnings season is typically very strong.

But the context is important both historically and current. We remain convinced that stock markets are in the final stages of the medium term uptrend since 2009, still following the 1929 and 1987 FITS template.

And, as we have pointed out before, it is not an actual fall in economic or corporate performance that causes a top into a crash but in a decline in the rate of improvement compared to an increasingly complacent bullish sentiment.

Here is the historical earnings comparison to 1920s and 1980s

Although earnings continue to improve the rate of improvement is slowing.

This week’s sell off can be seen then as a dress rehearsal for a later much larger reversal. Ironically similar in narrative and price action to the February rout and therefore seemingly at odds with both 1987 and 2009. And yet remarkably similar to the price action in 1929.

Complacency has turned to fear.

For the seven fear and greed indicators used to compile this chart, see The fear factor was clearly evidenced by the ramp in VIX (up 43% on Wednesday, the largest move since February, and 33% for the week), an inversion of the Stock-Bond correlation and the consequent fall in the Dollar (even though Gold may appear relatively subdued).

Does this quick turnaround in sentiment from complacency to fear suggest the generally stable to strong earnings season is an opportunity to buy?

Does this quick turnaround in sentiment from complacency to fear suggest the generally stable to strong earnings season is an opportunity to buy?

The answer is yes and no. It depends on the particular stock and where the indices are in the next 30 days. With the general break down in correlations we can expect some stocks to do well and others poorly. With many market reactions to earnings releases triggered by revenues rather than profits it will also be a question of identifying what will move the stock. JPM’s poorer revenues reported on Friday saw it trading like a miss rather the beat its profit suggested.

This focus on revenues will be particularly true for growth stocks such as FANGs. NFLX is due to report on Tuesday at what we think will be a highly volatile day for the markets generally.

The market was shocked this week. There are plenty more surprises and opportunities to come as volatility is likely to remain high into year end, and, we believe, two way volatility.

Sometimes the market needs to be shocked. It typically leads to much cleaner clearer and more volatile price action as evidenced by the second half of this week. Although we believe some stock indices have turned, the outlook for US yields and stocks for the last quarter suggest the World Index will be a mixed affair as indeed so will USD trading.

Being selective remains the mantra for 2018—for now. Timing is almost everything. But how do you know the right time or indeed which clock to use?

Here’s to making the very best.

Good Luck

Ed Matts
Matrix Trade

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